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May 20, 2013

Bond Investors Must Prepare for Rate Spike: SEC’s Walter

Former chairwoman says that she continues to be “disturbed” by how the SEC has “ignored” the fixed-income market

Updating Form ADV and Form U4
When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.

SEC Commissioner Elisse Walter (left) addressed a number of top issues for the industry on Monday—chief among them the immediate need to educate bond investors about spiking interest rates, which are inevitable.

During a session moderated by FINRA’s chief legal officer Bob Colby, Walter responded to questions from the audience of 1,000 attendees, made up primarily of chief compliance officers. Walter also gave her views on the pace of various SEC rules, including the agency’s fiduciary standard rule for brokers, the ban on general solicitation of private placement offerings and a rule on 12b-1 fees.

One attendee asked Walter to give her take on the “looming disaster for bond investors when interest rates go up.” In response, Walter said she agreed that most bond investors don’t understand how rising rates would negatively impact their bond portfolios. Investors “need to understand” how rates impact their bond portfolios “because they are making investment decisions today that will be impacted by that.”

Walter said that she continues to be “disturbed” by how the SEC has essentially “ignored” the fixed-income market. “The fixed-income market structure, or lack thereof,” which includes the municipal and corporate bond markets, is “hugely important to investors,” she said. “We tweak the equity markets constantly … but we have largely ignored the fixed-income markets” and how to make them better.

Walter added that she worries about bond investors’ inability to access price data on bonds. “If you are a retail investor and you choose to sell a bond, you don’t have a price discovery mechanism to look to—to make sure you’ve gotten a fair price,” Walter said. “We need more pre-trade transparency.”

As to the SEC’s rule to put brokers under a fiduciary mandate, Walter said she believes it’s time for the commission to “get to the nitty-gritty”of how the rule should take shape.

While using information culled from the latest round of public comments on the costs and benefits of a fiduciary rule will help the agency get there, Walter said that she hoped the second round of comments the agency receives will include more data, as the first set of comments have not.

Reiterating her support for a uniform fiduciary duty for brokers, Walter said she believed “the cost of brokers becoming fiduciaries is very low.”

When asked by one attendee if the SEC and the Department of Labor were collaborating to address one of brokers’ biggest concerns about the DOL’s fiduciary rule—brokers being unable to sell IRAs within 401(ks)—Walter responded that both agencies had been “in close contact” regarding their rules, and that she believed the issue would “be taken into account.”

John Ramsey, acting director of the SEC’s Division of Trading and Markets, noted during a panel session after Walter’s remarks that the SEC staff was “conscious” of the industry’s concern about DOL’s fiduciary rule and wanted to hear those concerns during its cost-benefit comment period. Most of the concern deals with “sales practice questions regarding rollovers of IRAs,” Ramsey said. “There could well be a role for FINRA to play with these sales practices.”

Walter also noted that a top priority for SEC Chairwoman Mary Jo White was finalizing the rule under the JOBS Act that will lift the ban on general solicitations of private placement offerings.

“I agree with all sides of this debate; I think the ban on general solicitation should be lifted,” Walter said. Noting the concerns raised about how lifting the ban could hurt investors, Walter said that “a lot of this debate is not really about general solicitation, but really the accredited investor definition, which is a perennial albatross for the commission.”

The JOBS Act directs the SEC to allow private-offering promotions as long as sales are limited to accredited investors—those who have sufficient wealth or access to information that would presumably allow them to make completely informed investment decisions. For an individual, that means a net worth of at least $1 million or annual income of at least $200,000.

It’s time for the agency, Walter said, “to decide what we should do with this definition,” adding that she believes the SEC should “get rid of the income and net worth standards and rely on an assets invested standard.”

As to when the SEC will make further reforms to 12b-1fees, Walter said the agency would not reach a conclusion during her time at the agency. But, she said, “I continue to be concerned about 12b-1 fees that go on forever.”